China Evergrande Crisis

What is Evergrande?

Evergrande is a Chinese property developer company also known as Hengda Group in China. It is the second largest property developer in China, owning more than 1300 projects spread across 300 cities. It was started by Chinese entrepreneur Xu Jiayin in southern part of China in mid 90s when Chinese economy liberalized and opened up to foreign money. Company also has interests in various verticals including wealth management and owns a football club with the name of Guangzou FC. The company grew on the tailwinds of growing Chinese economy and its middle class contributing a great deal to the growing Chinese housing market.

 

What is Evergrande crisis?

Basically, excessive debt which the company is finding hard to service. Its debt stands at $300 Billion as of today. While the company grew rapidly with the broader Chinese economy and the growing middle class demanding homes amidst a property boom, its debt also continue to increase and has reached unmanageable proportions. China has its debt issue for more than a decade, the whole world is privy to it. Real estate has been tipped to be the storm that is going to kick the biggest can of worms in the history of Chinese economy. Real estate contributes to almost 30% of Chinese economy which is a disproportionately high share. Any issue within the property market is likely to start a contagion in the broader economy which the government and policymakers are fully aware of. Many are calling it China’s Lehman Brothers moment.

While Evergrande has gained the distinction of the world’s most indebted real estate company, the development doesn’t come as a surprise. It has to make offshore interest payments of around $84 million on Thursday which is keeping the financial markets at tenterhooks.

 

Will the Chinese government help Evergrande?

It is the most important question everybody is asking. While Evergrande is too big to fail, the broader policy framework adopted by Chinese president Xi Jinping and the Chinese congress rests on cleaning the Chinese economy and moving away from inflated debt-ridden growth model to a more sustainable equity led growth with a tinge of socialist flavor. Any signal of bailing out Evergrande would be seen as a departure from the president’s vision. It is also important to safeguard the common man and their lifelong hard-earned savings which they have invested for their homes. If Evergrande fails, they will lose their deposits. This leaves the policymakers between a rock and a hard place. How they maneuver out of this would be interesting to see.

Lately the administration has not been so kind to Chinese corporations. They have been categorically told to keep the Chinese state and common man’s interests above their monetary interests. The episode with Alibaba and Jack Ma is for everybody to see, also the tech giants and ride hailing companies were dealt with severely.

 

What would be the effect on Chinese economy?

If the government bails out Evergrande, this would be a great step towards cleaning the real estate market and even nationalizing it, which aligns with the vision of the Chinese leaders. Better regulations would lead to less inflating of real estate prices and affordable property development and sale. One thing is sure, if the government bails out Evergrande, it won’t be a one-off case. There are many other smaller players who are debt ridden and closely following the government’s move. If the government steps in, it would be to completely overhaul the real estate market and not otherwise.

If the government chooses to stay away and let market go through its natural cleanup, there would be a likely contagion that will be seen in the broader Chinese economy. If Evergrande fails to service its debt obligations, the financial institutions that have an exposure to it would be the first ones to go under. This would create risk averseness in the broader financial market and lending would halt. Evergrande owes money to around 170 domestic banks and 120 other financial institutions, which is a lot of exposure.

Evergrande is just the tip of the iceberg, as I mentioned there are many others in line. The combined exposure would be around three times Evergrande’s valuation.